Lockups Revisited

Abstract

We present a theoretical model that shows how the incentives of insiders, underwriters, and investors can interact with the nature of the firm's assets to explain the existence of lockup agreements. Lockups are commitments by insiders of stock-issuing firms to abstain from selling shares for a specified period of time after the issue. Our model shows how lockups can be a signaling solution to the adverse selection problem resulting from information asymmetries at the time of the stock issue. Specifically, insiders of good firms put and keep (lock up) their money where their mouth is, a signal that can be too costly for insiders of bad firms. Our model yields two comparative statics: lockups should be shorter when the degree of asymmetric information is small (high-transparency firms) and when the cost of mimicking is high (risky firms). Using a sample of 4,013 initial public offerings and 3,279 seasoned equity offerings between 1988 and 1999, we find empirical support for our theoretical predictions.

Keywords: Lockup, Signaling, New Equity Issues, IPO, SEO

JEL Classification: G14, G32